Run-on with purpose, buy out later 

The new DB funding regime will soon require all pension schemes to set a long-term objective - a decision about how a scheme’s trustees and sponsor plan for benefits to be paid over the long term. We are beginning to see a swing of the pendulum in the industry away from buyout and towards run on. However, this is not a binary decision. 

Most realistic long-term strategies will accommodate a period of run-on followed by a transfer of liabilities to an insurer, or possibly alternatives such as superfunds. Even the best funded schemes would not be able to secure benefits with an insurer immediately and require at least a short period of run-on; transactions take time. At the other end of the spectrum, perpetual run-on is not a realistic choice of end game - all schemes’ lives will come to an end. So, the key question is when the risk transfer should take place. 

For many schemes whose focus until recently has been benefit security, for example eliminating funding deficits and stabilising volatile funding positions, the instinctive answer might be “as soon as possible”. Without doubt that will be a sound decision for some, but not for all.  

When might a period of run-on, be in members’ interests, even when your scheme is already at, or close to, full funding on a buyout basis? Here are a few scenarios: 

Not all options and flexibility available to members, especially at retirement, can be replicated through an insurer contract.  While running on, long-standing scheme flexibilities and trustee discretions can continue to provide these benefits, helping trustees to maintain a positive member experience. 

There is a risk that a buyout contract doesn't secure the benefits perfectly. Scheme rules documentation emerging, unknown members coming forward and legal judgments being handed down can all have an impact. Residual risk cover and an employer indemnity can provide some protections, but arguably an active trust can better react, more quickly and effectively paying members the right benefit. 

Buyouts come at a cost compared to even a very low risk run on strategy. 

While running on, schemes might be able to provide more valuable member option terms, enhance the overall member experience or provide discretionary benefits.  

Of course, upside needn’t be limited to members and can be shared with sponsors too. Sacrificing the security of an insurance transaction for the benefits of a longer period of run on will depend on a number of factors and vary from scheme to scheme. 

An effective period of run on should be much more proactive than simply “not buying out”. Trustees and sponsors will need to consider areas such as integrated risk management, member experience, how any surplus should be used, along with the best governance model to deliver this. 

Planning for an endgame is not a simple choice between buyout and run-on. With the incoming funding regime, TPR’s annual funding statement encouraging trustees to reconsider plans and the prospect of further legislative change, long term strategy will be a current area of focus for many trustees and sponsors.